Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the potential economic loss arising from adverse changes in market factors. Our exposure to financial market risks results primarily from fluctuations in foreign currency exchange rates, interest rates and equity prices. Aggregate risk exposures are monitored on an ongoing basis.
Foreign Currency Exchange Rate Risk
We are exposed to risks from foreign currency exchange rate fluctuations that are primarily related to changes in the functional currency value of revenues generated from foreign currency-denominated transactions and changes in the functional currency value of payments in foreign currencies. We manage these risks by entering into foreign currency forward contracts that hedge exposures of the variability in the functional currency equivalent of anticipated non-functional currency denominated cash flows. Our foreign currency exchange rate risk management program reduces, but does not entirely eliminate, the impact of foreign currency exchange rate movements.
At September 30, 2020 and 2019, the aggregate notional amounts of our foreign currency forward contracts outstanding in our exchange rate risk management program, including contracts not designated for cash flow hedge accounting, were $3.9 billion and $3.1 billion, respectively. The aggregate notional amount outstanding at September 30, 2020 is fully consistent with our strategy and treasury policy aimed at reducing foreign exchange risk below a predetermined and approved threshold. However, actual results could materially differ from our forecast. The effect of a hypothetical 10% strengthening or weakening in the value of the functional currencies at September 30, 2020 is estimated to create an additional fair value gain of approximately $210 million or loss of approximately $260 million, respectively, on our outstanding foreign currency forward contracts. The gain or loss from this hypothetical strengthening or weakening would be largely offset by a corresponding gain or loss on our cash flows from foreign currency-denominated revenues and payments. See Note 1—Summary of Significant Accounting Policies and Note 13—Derivative Financial Instruments to our consolidated financial statements included in Item 8—Financial Statements and Supplementary Data of this report.
We are further exposed to foreign currency exchange rate risk related to translation as the functional currency of Visa Europe is the euro. Translation from the euro to the U.S. dollar is performed for balance sheet accounts using exchange rates in effect at the balance sheet date and for revenue and expense accounts using an average exchange rate for the period. Resulting translation adjustments are reported as a component of accumulated other comprehensive income (loss) on the consolidated balance sheets. A hypothetical 10% change in the euro against the U.S. dollar compared to the exchange rate at September 30, 2020, would result in a foreign currency translation adjustment of $2.2 billion. See Note 1—Summary of Significant Accounting Policies to our consolidated financial statements included in Item 8—Financial Statements and Supplementary Data of this report.
We are also subject to foreign currency exchange risk in daily settlement activities. This risk arises from the timing of rate setting for settlement with clients relative to the timing of market trades for balancing currency positions. Risk in settlement activities is limited through daily operating procedures, including the utilization of Visa settlement systems and our interaction with foreign exchange trading counterparties.
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Interest Rate Risk
Our investment portfolio assets are held in both fixed-rate and adjustable-rate securities. Investments in fixed-rate instruments carry a degree of interest rate risk. The fair value of fixed-rate securities may be adversely impacted due to a rise in interest rates. Additionally, a falling-rate environment creates reinvestment risk because as securities mature, the proceeds are reinvested at a lower rate, generating less interest income. Historically, we have been able to hold investments until maturity. Neither our statements of operations or cash flows have been, nor are they expected to be, materially impacted by a sudden change in market interest rates.
The fair value of our fixed-rate investment securities at September 30, 2020 and 2019 were $4.0 billion and $1.8 billion, respectively. The fair value of our adjustable-rate debt securities were $2.0 billion and $4.6 billion at September 30, 2020 and 2019, respectively. A hypothetical 100 basis point increase in interest rates would create an estimated decrease in fair value of approximately $3.5 million on our investment securities at September 30, 2020. A hypothetical 100 basis point decrease in interest rates would create an estimated increase in fair value of approximately $7.2 million on our investment securities at September 30, 2020.
In fiscal 2019, we entered into interest rate and cross-currency swap agreements on a portion of our outstanding senior notes that allow us to manage our interest rate exposure through a combination of fixed and floating rates and reduce our overall cost of borrowing. Together these swap agreements effectively convert a portion of our U.S. dollar denominated fixed-rate payments into euro denominated floating-rate payments. By entering into interest rate swaps, we have assumed risks associated with market interest rate fluctuations. A hypothetical 100 basis point increase in interest rates would have resulted in an increase of approximately $30 million in annual interest expense. See Note 13—Derivative Financial Instruments to our consolidated financial statements included in Item 8—Financial Statements and Supplementary Data of this report.
Equity Investment Risk
As of September 30, 2020 and 2019, the carrying value of our non-marketable equity securities was $1.0 billion and $0.7 billion, respectively. These investments are subject to a wide variety of market-related risks that could substantially reduce or increase the fair value of our holdings. A decline in financial condition or operating results of these investments could result in a loss of all or a substantial part of our carrying value in these companies. We regularly review our non-marketable equity securities for possible impairment, which generally involves an analysis of the facts and changes in circumstances influencing the investment, expectations of the entity’s cash flows and capital needs, and the viability of its business model.
Pension Plan Risk
At September 30, 2020 and 2019, our U.S. defined benefit pension plan assets were $1.1 billion and projected benefit obligations were $0.9 billion at each year end. A material adverse decline in the value of pension plan assets and/or in the discount rate for benefit obligations would result in a decrease in the funded status of the pension plan, an increase in pension cost and an increase in required funding. A hypothetical 10% decrease in the value of pension plan assets and a 1% decrease in the discount rate as of September 30, 2020 would result in an aggregate decrease of approximately $221 million in the funded status and an increase of approximately $44 million in pension cost.
At September 30, 2020 and 2019, our non-U.S. defined benefit pension plan assets were $0.5 billion at each year end and projected benefit obligations were $0.6 billion and $0.5 billion, respectively. A material adverse decline in the value of pension plan assets and/or in the discount rate for benefit obligations would result in a decrease in the funded status of the pension plan, an increase in pension cost and an increase in required funding. A hypothetical 10% decrease in the value of pension plan assets and a 1% decrease in the discount rate as of September 30, 2020 would result in an aggregate decrease of approximately $194 million in the funded status and an increase of approximately $17 million in pension cost.
We will continue to monitor the performance of pension plan assets and market conditions as we evaluate the amount of our contribution to the pension plans for fiscal 2021, if any, which would be made in September 2021.
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